So let us look at US manufacturing new order data, at first in terms of the frame, which bounced back on a monthly basis in April:

The frame

We can see from the following chart that annualised real growth rates over rolling 10 year time frames (using new order data adjusted for PPI and smoothed) have been heading downwards since the start of the decade. The real annualised rate of growth over rolling 10 year time frames shows that the current cycle is much weaker than the pre 2008 cycle.

We can see the step down in growth more easily if we just view the high water mark dynamics (which ignores the current index level if it remains below the HWM).

In reality given the declines in flows since 2014, new orders for manufacturing adjusted for the PPI stand below levels reached at the end of the 1990s, and yet, here we are all worried about the risk of recession when the risk of something far greater has already occurred. Tied into the frame is the key dynamic of global rebalancing: cheap labour in emerging/developing economies had offshored a significant amount of manufacturing output from the late 1990s onwards (the weak order data partly reflects this) and the expected maturing of developing economies consumers and rising wage costs was anticipated by many to create a rebalancing of global economies. This is presently at risk a) due to the time frame of transition being longer than many expect and b) given that technology is driving out labour in key industries.

And in the next chart we see nominal annualised rates for new orders over rolling 10 year time frames: clearly the structure and balance and dynamics of the US economy and the attendant global economic dynamics are unable to support the type of growth the economy had experienced in post WWII years. The primary issue we are facing today is not one of a prospective recession but of a weakening frame:

In a slowing growth frame less of a corporation’s revenue flows are likely to be reinvested and productive capital is likely to be increasingly depreciated over time, depending on the rate of decline of the frame. At the moment this cash flow, distributed as either dividends or buybacks, is likely to go disproportionately to those with higher wealth and hence more likely to be reinvested in existing assets, driving up their prices.

In a competitive economic model cash flows would be used to finance the transition to lower growth, with flows consumed and/or used to reduce debt. As people age the costs associated with complex medical and personal care needs rise, but these are liabilities that are presently not that well funded. It makes sense to optimise the allocation of flows to a) fund the economic costs of older adult communities and b) make sure that those at the younger end of the scale continue to receive the necessary education and employment skills training. This would ensure that the expenditure flows in the economic habitat would be healthier in terms of optimising expenditure and investment. Imbalances due to inefficient distribution of flows are likely to lead to higher asset price and financial system risks.

In a growth frame where higher levels of productive capital investment is needed it makes sense to have lower corporate tax rates, but in a slower growth frame where higher percentages are distributed it would make sense to tax these distributions at higher levels for more efficient distribution. In a competitive efficient market place without asymmetric properties we would be less likely to have the present skewed distribution of income and wealth and associated funding pressures on key aspects of social infrastructure.

I was reading “Helicopter drops might not be far away” by Martin Wolf in the FT. By now those interested in macro economics/monetary policy/asset markets should be well aware of the long gradual easing in interest rates, especially since the 1990s. Lower interest rates did not just encourage people to borrow for consumption, but they also boosted the amount of borrowing for asset purchases with rising asset values also looping back into consumption for a while. During this period, global money supply growth also became ever more asset focussed.

For a while this helped stimulate consumption in key economies, also aiding in developing economy growth. Developed economy consumers became ever more indebted at a time when income growth was also slowing, but given that asset markets kept rising and interest costs kept falling, everything was able “to keep on going for a while”…many felt that this period of low interest rates and rising asset markets was a “great moderation” and few seemed to notice the enveloping divergence.

While the financial crisis was the bursting of this particular reality, it also marked the onset of a period of unprecedented financial engineering in response, itself a denial of that reality.

What we are seeing is a misconstrued extenuation of policy applied to a once rising frame, and indeed it is plausible that we have been following a path of unconventional monetary policy for a much longer time. What we thought were monetary shocks on the way up were merely reactions to divergences occasioned by overly aggressive expansion of money supply.

In its recent World Economic Review the IMF nicely, if not completely, summarised many of the world’s economic issues. One thing clearly communicated was that global economic growth is both slowing down and in transition and that this must have consequences for monetary policy.

The world has become increasingly dependent on debt (principally new money supply growth originated debt and asset focussed MS’s velocity dynamic within the asset sphere) to finance consumption, investment (and increasingly to a much greater extent, financial leverage), and while this was fine as long as growth barrelled along, incomes rose and populations continued to grow, it all started to go pear shaped as the engine started to wobble. Lower interest rates designed to encourage consumption and investment, and loan growth financing the two, did just that and more so: in fact one of the consequences of lower interest rates was to increase the asset focus of money supply growth; a secondary consequence was to provide a source of additional expenditure (US especially) via home equity lines of credit drawing off rising asset values, at least until 2007.

An inversion of many of the factors that had at one time driven growth were reversing at precisely the same time that debt and debt financed consumption expenditure was rising (1990s) and this is well evidenced in Japan. Well we all know what happened next, ultimately the 2007/2009 financial crisis, but also a string of financial wobbles along the way.

Slowing growth and rising debt could not coexist within the rising interest rate environment of the mid 2000s and hence we arrived at 2007 and onwards. In truth, declines in interest rates and growth rates, combined with rising debt, on a global basis, have created a veritable choke hold and “post much greater QE”, one with increasing volatility and sensitivity to changes in monetary flows. The overall complex whole is full of transitional issues, and these are discussed at length in many previous posts: understanding these various strands impacting demand and supply, loan growth and structural imbalances both domestically and globally is important if you are to be able to translate the many competing nuanced arguments being expounded both for and against unconventional monetary and dare I say it fiscal policy.

That said, we have remained remarkably transfixed on the one size fits all monetary policy to drive growth forward, hoping that low interest rates will spur borrowing for consumption and investment and somewhat erroneously hoping that those with cash will spend it. Ultimately we are hoping that QE will drive the animal spirits and re awake the growth of good times past.

In the typical economic model with its rationale agent, the agent would be focussed on maximising short and long term consumption/saving from a given income. Changing interest rates and inflation assumptions would immediately impact key consumption/saving decisions, and so the balance of expenditure between consumption and investment/savings. But agents on average are neither wholly rationale nor are resources (income and wealth) equitably spread. Moreover, the resources available for consumption and expenditure are not necessarily constrained to income/capital, but extend to new bank originated loans.

Indeed the accumulation of imperfect decisions and growing imbalances as well as emergent dynamics (deflating/inflating economic frames and the changes they bring to key economic relationships) can constrain the impact of IRs and money supply on natural adjustment mechanisms. In other words simple models ignore the actual balance of factors and the impairment of those factors in terms of their sensitivity to policy tools such as interest rates.

The problem is that as growth slows, the amount of new money supply growth (loan or QE originated) should also decelerate, something which has not really happened. In a slowing growth environment (one that may be characterised by a declining economic frame: population growth, demographics, productivity, increasing income inequality) we become ever more dependent on a market’s balance and allocational efficiency, that is the relationship between productive capacity/asset and debt values to changes in supply and demand dynamics and the distribution of income/wealth needed to maintain an appropriate balance of consumption and investment in a frame as it transitions.

What we have been doing is increasing money supply growth as growth falters and falls, all the while accentuating many of the imbalances hindering necessary frame transitions. This has raised debt/equity values as GDP and income growth slows, increasing the sensitivity of the markets and the financial system to growth and changes in growth and raising the latent size of associated future demand shocks. The solution has been to continually lower interest rates and when interest rates have been as low as they can go to swap debt assets for newly created central bank money. We now appear to be about to extend this sequence, by reducing interest rates below the lower bound.

What we appear to have confused are the one time solutions to recessions occasioned by monetary tightening, that is to reduce interest rates as activity declines, in expanding frames, to applying the same medicine for a declining growth/deflating frames. The argument being that the recessions were caused by monetary shocks impacting demand and hence any demand deficiency can be dealt with by monetary stimulus: well, of course, monetary stimulus can of course influence demand, but not without creating imbalances between assets and their value and the frame and capacity, at times, and the growth rate of the frame.

In short, we do not need more money supply growth as a frame deflates, but an adjustment of the capacity and related capital (debt/equity values) so as to minimise divergences between growth and capital, including debt and its many forms, and hence to minimise shocks to the financial and the economic re maintaining balance between the two.

What we are seeing is a misconstrued extenuation of policy applied to a rising frame, and indeed it is plausible that we have been following a path of unconventional monetary policy for a much longer time. What we thought were monetary shocks on the way up were merely reactions to divergences occasioned by overly aggressive expansion of money supply.

I personally feel that arguments to reduce interest rates below the zero bound are seriously flawed, but flaws themselves ingrained into the body economic and financial for too long for many to be able to differentiate the reality of the trajectory.

Irrespective, deflation is not the issue, but slowing growth within a complex frame over burdened with financial excess and key structural imbalances.

A recent speech by Andy Haldane has kept the interest rate/zero lower bound debate “bubbling”. In this speech, “How Low Can You Go”, Haldane broached the issue of monetary policy in the event of another demand shock. He is quite right to do so since monetary policy would have little room for manoeuvre with interest rates only a scuff mark away from 0%. His musings suggested getting rid of cash and bringing in negative rates.

A recent IMF report pointed out some supposed vast amounts of room available for the world’s economies to step up government borrowing to finance consumption, investment and production decisions. Oddly the report appeared to ignore other forms of debt and material deterioration in key areas of the economic frame.

When the crisis broke back in 2007 it was clear to me that monetary and fiscal policy would likely need to go for broke to support economic growth and employment at a time of collapsing asset values, debt defaults and a world wide retrenchment in expenditure of all kinds. As it happened a great deal of that support went into asset prices and financial institutions.

But some years after the crisis, after a slow and drawn out recovery with interest rates locked to the floor, economies still appear to be borderline reliant on debt financed government expenditure. Any attempt to reduce borrowing, to either raise taxes or cut expenditure to pay back debt would be considered by many to have an adversely negative impact on economic growth, especially at such low growth rates.

This is a quickly penned thought on Andy Haldane’s recent comments on interest rates and deflation:

In a recent speech Andy Haldane of the Bank of England suggested that interest rates may well need to fall as opposed to rise following on from recent falls in inflation. I would agree that the secondary impacts of price declines need to be seen before we can assess whether or not these price falls could indeed trigger stronger deflationary forces.

For one, price declines may lead to lower revenues (note US retail sales) and lower revenues may impact on wage increases.

Thirdly, we are in a complex deflationary frame where aging populations, slowing population growth and relative weakness in corporate investment (note buybacks) is already a significant drag on the global economy. Falling prices could well trigger latent dynamics in this structure.

And finally, areas of the world which could well create the demand necessary to reinvigorate the frame, for example China where growth appears to be slowing sharply, may also be adding to tensions within the global growth frame.

So yes, interest rates could fall, in the sense of defending asset prices and attempting somehow (I do not quite know how) to reinvigorate or at least support demand, or rather maintain marginal cash flows.

But in reality we do not know because we lack at the moment a measure of the sensitivity of the frame to short term shocks of any financial or economic nature. We know the frame is weak and has been for some time but as to its sensitivity, we know very little.

One of the risks with short term data points is being fooled by their randomness. I believe the US economic engine is slowing down and that weight of the past remains a significant head wind!

A number superlatives are cropping up re final Q3 GDP numbers:”fastest pace since Q3 2003” and others…

But what of the frame? If we look at the average increase in real GDP over the last 4 quarters (average change in GDP over 4Qs/average GDP in prior 4 quarters) we see that real GDP growth is relatively low in an historical context and it is unclear whether the current trend is either a bounce back from earlier weakness or a position of growing strength.

Importantly private consumption expenditure is still outsized with respect to economic growth and other important items such as machinery and equipment expenditure. That is much of the growth in GDP to date has been due to growth in personal consumption expenditures:

I remember back in the 1990s looking at long term Canadian stock market performance and thinking how lacklustre it had been. Since then of course things changed: while many markets have fallen back below levels reached in the 1990s (UK, France, Japan, Italy) Canada’s stock market, up until recently, has been ratcheting up one peak after another; its markets have behaved more like developing Asian markets (South Korea, Hong Kong etc).

Commodity price and production increases have played a large part in much of post 1990s economic performance as has a considerable debt financed house price/construction boom and other debt financed consumer expenditure.

With the recent hefty collapse in oil (other commodity prices have been falling for a while too) it is worth asking whether Canada’s mini golden age has passed. Certainly the boost that came from a debt financed property market boom is unlikely to be repeated and the consequences of debt more likely than not to weigh on future economic growth. Additionally, China, a key figure in the growth of world trade and demand for commodities post 1990s is slowing down.

But what of other dynamics? Well population growth and aging are very important and have likely been a major factor in slowing global growth. If we look at employment growth between 2000 and the present point in time we see that Canada has significantly outperformed the US and a good part of its economic performance has likely been due to this superior metric:

Recently a Statistics Canada report eulogised Canada’s population growth, the highest amongst G7 economies but I see more troubling trends behind the data:

The age 65 and over population is expanding rapidly at the same time as under 20s has actually been falling. Back in 1990 12.5% of the US population was over 65 and 28.8% was 19 and below. In Canada the respective figures were just under 11% and 27.7%. By 2013 US over the age of 65 had risen to 14.14% and those under 20 had only fallen to 26%. In Canada the respective figures were 15.3% and 22.3%. The trend is divergent: the working age cohort in Canada started at a higher level and has now shrunk to a lower level and looks set to fall further.

We can see the growth rate of the key 20 to 54 age group has been declining steadily.

We also note that employment growth in the 20 to 24 age group (and hence the 20 to 54) had benefited some from a recovery in growth (long since past) in the 0 to 19 age group from the mid 1980s to the late 1990s. This has now worked its way out of the system.

Canada has seen relatively strong employment growth from the late 1990s to around 2008, which had held up reasonably well post 2008. But if we assume that the 0 to 19 age group is declining and that the surge in employment growth has been due to a temporary surge in growth in the younger cohorts, expect employment and economic growth to suffer. Also expect demand for highly priced properties to abate.

Poor demographics and high levels of debt combined are highly deflationary. Moreover high levels of debt and slow economic growth risk further weakening population growth, compounding growth and debt problems. This to my mind is a key reason why we need to worry a lot more about debt levels.

I had prepared some Japanese charts at the time of the Q3 GDP announcement and for one reason or another failed to complete the analysis. Well here are the charts I was working on:

In my previous post I posted a graph of key US labour market dynamics…the growth in US employment (based on high water mark analysis). We know that there has been a slowdown in labour growth dynamics at the same time as we have had an increase in debt, increasing market volatility and a slowdown in economic growth. But did the financial shock and the long term impact of the unwinding on debt lead to weakening labour market dynamics or did weakening labour market dynamics leverage the impact of the shock and the debt?

Total new manufacturing orders rose 1.56% in February following declines in January (1.03%) and December (2%). Orders are 0.6% below February 2013 levels. The bigger picture is of the course the more worrying:

And the bigger picture is that historically declines in orders have always been accompanied by declines in the Federal Funds Rate. I will not need to go too far into the fact that rates have not risen as they usually do. So why is the Fed tapering? Well, while asset prices have risen fine and dandy, underlying economic growth has not similarly responded.

And we see the same picture with respect to producer price inflation:

If QE has not worked and interest rates are as low as they can go and sovereign debt is as high as it can go, where do we go from here?

Interestingly the BEA prices indexes used to deflate nominal data to arrive at real GDP growth shows a deflationary trend in goods, an inflationary trend in services and residential and non residential structure investment. Part of the larger than expected increase in Q2 GDP may be ascribed to the lower price deflators.